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You have just learned that a key customer or supplier is in financial distress. A Chapter 11 bankruptcy petition may be imminent, or perhaps already filed. While recognizing the severity of the problem, do not hit the panic button. Terminating your relationship with the troubled company may not be in your best interest. Nevertheless, some remedies have legal deadlines, and some strategies you might wish to pursue may require speed in order to be effective.

Pre-bankruptcy

If the troubled company is not in Chapter 11, here are some approaches to consider:

Do your own due diligence. Rumors of financial distress are sometimes false. You do not want to destroy a valuable relationship by jumping to conclusions.

Did you recently ship goods to the distressed company? If the goods are still in transit or if the distressed company has received delivery of the goods within the last 10 days, or if you received a representation of the buyer's solvency within the last three months, consider exercising your rights (stoppage of delivery/reclaiming goods) under the Uniform Commercial Code.

Have you recently received a payment? If the distressed company goes into bankruptcy, any payment within 90 days before the bankruptcy petition (one year in the case of an "insider") may be a "preferential transfer," which will have to be disgorged. Fear of having a payment avoided should not deter collection efforts, and payments should always be accepted.

Should you file a lawsuit immediately? If you do not mind jeopardizing your relationship with the debtor or possibly pushing the debtor into bankruptcy, you should consider a prompt lawsuit.

Should you keep selling to the debtor? There are ways to continue selling to a distressed company without increasing your potential credit exposure. You could require payment in advance, sell on a C.O.D. basis, or you might wish to deliver new goods only after first receiving payment for the same amount of old goods.

What if you have a long-term contract with the buyer? If you have good reason to believe that the buyer will not perform, you may have the right under the Uniform Commercial Code to demand adequate assurance of the buyer's performance, or you may be able to break the contract without penalty.

After the Chapter 11 filing

If your customer files a Chapter 11 petition, the rules change. The petition triggers the automatic stay, which bars most types of collection activity. However, you still may have a right of reclamation or stoppage in transit, but timing is critical. Some further considerations:

Should you keep selling to the debtor? Ironically, a Chapter 11 debtor may be a better credit risk than a company outside of Chapter 11. That's because obligations incurred by the debtor after filing under Chapter 11 are "administrative expenses" entitled to priority over all other unsecured obligations.

Can you be designated a Critical Vendor? In certain instances, a debtor will seek to designate certain of its suppliers as "critical vendors." Obtaining critical vendor status may provide a unique opportunity to obtain payments on account of prepetition debts that you otherwise may not be entitled to receive.

Can you collect for goods recently shipped? The Bankruptcy Code provides administrative-expense treatment for unpaid goods received by the debtor within 20 days before the bankruptcy filing.

What if you have a long-term contract with the debtor? The debtor will probably have the right to assume or reject the contract.

If the contract is assumed, the debtor typically may choose to perform the contract itself or to assign the contract to a third party. If the contract is rejected, then it will not need to be performed and you will likely have a general unsecured claim for whatever damages you suffer because of the debtor's breach. If the contract is assumed, however, both sides will be required to perform the contract, including payment in full of all monetary obligations.

Doing business with a financially distressed customer is not without its challenges and risks. However, if those challenges and risks are properly managed, you may be the beneficiary of a continued business relationship. But if the warning signs of your customer's financial trouble are mounting and past being able to be managed without reasonable comfort of getting paid, swift action must be taken.

NH Legal Perspective is a bi-weekly column sponsored by Sheehan Phinney Bass + Green PA. This column does not provide legal advice. We recommend that you consult an attorney for specific guidance on legal questions.